Is India heading towards its own banking crisis?

Aug 24, 2011

In this issue:
» Soros' theory of reflexivity playing out for the US economy?
» Greenspan: Euro is on the verge of breaking down
» China set to reverse its currency policy
» Japan too gets a debt downgrade
» ...and more!

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For long, Indian banks have been known to be prudent and well-capitalised. What better proof of that than the resilience shown during the 2008 financial meltdown that saw quite a few global banking giants go under the water.

However, there are quite a few indications that the Indian banking industry is heading into troubled waters. The Indian economy is for the first time since 2009, showing signs of a slowdown. Policymakers have cut the GDP (Gross Domestic Product) growth forecasts for the current fiscal from 9% to 8% on account of an unfortunate mishmash of rising interest rates, skyrocketing commodity prices and the economic turmoil in the developed economies. This has led many Indian companies to either restructure or default on their debt. As a result, the non-performing assets have been piling up on the balance sheets of Indian banks.

Several recent reports have been sounding the alarm bell for the banking sector. For instance, a report by IDFC Securities suggests that at least 17% of Indian banks' outstanding loan assets could be on the verge of default. The Indian rating agency, Crisil, expects overall bad loans held by Indian banks to rise from 2.3% to 2.6% in the financial year 2011-12. The Reserve Bank of India, too, has raised concerns about the deteriorating credit condition. The Indian central bank has warned that non-performing assets could rise by 25% this year to 2.92% of total portfolios. To just give you an idea of what that means, bad loans at US banks last year stood at 3% of total loans.

Public sector banks, especially, are witnessing a large share of this deterioration in asset quality. These banks are, however, blaming the shift to a system-based recognition of NPAs for the sudden increase in bad loans. Earlier, the calculation for these banks was done at a branch level, and was thus, subject to the discretion of managers. With the loss of this human element of forgiveness, NPAs have shot up. On the positive side, this helps us get a more accurate picture of the bank's asset quality. Nonetheless, due to the shift in NPA accounting system coupled with the high interest rate regime, their quarterly profits have grown by single digits on account of higher provisioning.

In conclusion, we believe that though the current economic challenges may hamper growth and profitability of Indian banks from a short to medium term perspective; the robustness of the Indian banking system governed by a prudent central bank can avert the manifestation of a major banking crisis.

Do you think the Indian banking system is strong enough to avert a banking crisis? Share your comments with us or post your views on our Facebook page.

 Chart of the day
Sovereign debt crisis in the West has questioned the credibility of currencies in those respective countries. We know that US dollar's status as the world reserve currency is under severe threat. And now it seems that people are losing faith in the Euro as well. Today's chart of the day shows how the Eurozone government debt has almost doubled in just a decade's time.

Former Federal Reserve Chairman Alan Greenspan is of the opinion that Euro is on the verge of breaking down which may create considerable difficulties in the European banking system. There is a general lack of confidence in holding euro-denominated debt right now. It may be noted that incessant lending by European Central Bank (ECB) has artificially kept many banks in Greece, Italy and Spain solvent. Once lending curbs are imposed solvency risk is likely to emerge. This may put further pressure on the Euro. Nonetheless, we believe that Europe may find its way out of the current debt trap by sharing the burden. Although this might further pressurise the Euro, allowing the weaker economies to default would mean that the entire European Union would be blown away by the debt bubble. And this may destabilise the banking system. Indeed, these are tough times for the Euro and the European Union.

Data source: DNA Money

Most of us have been brought up with the idea that in stocks, it is the fundamentals that drive the price. Thus, if a company has high debt and reports poor earnings, its stock price will certainly take a tumble. But how about thinking the other way round? What we mean is can stock prices drive fundamentals. If a certain George Soros is to be believed, they certainly can. Consider the case of an all-stock acquisition. If the share price of the acquiring company is high, it may not have to take on extra debt to fund the deal. On the other hand, if the price is low, the deal may turn into a leveraged buyout. Therefore, as can be seen, different stock prices can lead to different fundamentals for the same company. This example thus shows that not only can fundamentals drive the stock price but the stock price can also drive fundamentals.

Using this very principle, Soros has argued that there is a strong chance of a double dip recession happening in the US. How? It is simple. There is a greater feeling amongst investors that economy is weakening and hence, they are selling shares and lowering prices. These lower prices in turn will further deteriorate the fundamentals of the stocks and consequently, the economy. Hence, there is a greater possibility of US double dipping in the near future than there was before. Sounds complicated but it does make some sense, doesn't it?

Till a few months back, China's currency policy was a key issue of debate between the developed world and China. China was accused of artificially depressing the value of its currency, Yuan. Nonetheless, China's currency did appreciate by around 6% over the past one year. But it is still not allowed to move freely in the currency markets like other currencies. However, this is all set to change.

China is discussing the option of allowing Yuan to be traded in the currency markets despite the concern that this would lead to an appreciation in its value. The reasons for this change in thought process are China's growing portfolio risk as well as high domestic inflation. China currently holds around US$ 3 trillion worth of foreign currency denominated securities. A fall in the value of any of the currencies would lead to erosion in the country's portfolio. At the same time, domestic inflation in China continues to remain high despite its monetary tightening efforts. An appreciation in the Yuan's value would help reduce its import bill which in turn could help combat demand led inflation. On the other side an appreciation of Yuan would be good for China's neighbours like India. As Chinese exports would get expensive, exports of other countries would benefit as they would become competitive on the global front.

When S&P's downgraded US' credit rating recently, it sent shockwaves around the world. And although the credit rating agency came under fire for its move, the act itself was hardly surprising given that US' debt had ballooned to something massive as a result of which a downgrade was long overdue. And now Japan has been thrown in with the US as well. Moody's Investors Service cut its rating on Japan's government debt by one notch to Aa3, blaming a build-up of debt since the 2009 global recession.

The fact that the Japanese government has not been able to come out with effective strategies to deal with its problems also led Moody's to downgrade the country's debt. Japan has many problems to deal with. On top of the global financial crisis, the recent earthquake and tsunami wreaked havoc on the country and its economy and stretched the government's finances to the limit. The country is also trying to grapple with a soaring yen, coming out with a new energy policy in the wake of the nuclear disaster and a significant rise in its ageing population. Moreover, frequent changes in the Japanese government have only compounded its woes. Indeed, it seems that the country will have to endure an arduous journey in the coming months.

In the meanwhile, Indian stock markets continued to trade in the red. At the time of writing, the benchmark BSE Sensex was down by 152 points (-0.9%). All the sectoral indices were trading in the red except for Consumer Durables and FMCG. All the Asian stocks markets were trading in the red with Hong Kong (down 2.1%) and Singapore (down 1.4%) leading the downfall.

 Today's investing mantra
"A loss never bothers me after I take it. I forget it overnight. But being wrong - not taking the loss - that is what does damage to the pocketbook and to the soul." -Jesse Livermore

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11 Responses to "Is India heading towards its own banking crisis?"

rakesh taneja

Aug 28, 2011

today if you ask any of your friend at bank he will tell you that about 90% of the managers in PSU BANK managing loans are currupt and with the help of CA,s they manupulate the accounts to give sanctions AND HENCE EARN PAYBACK RANGING FROM 3-10% . MARGIN MONEY IS ALSO PAID OUT OF THIS SANCTIONS I.E LOANER DOES NOT HAVE ANY INTREST IN THE PROJECT OR IS NOT WILLING TO PAY INSTALLMENTS


Chandrashekhara S

Aug 26, 2011

The article is good. The words stated in the article is true as I am from Public Sector Bank Family. I feel whole public sector bank is tending towards danger zone. It has become people dependant. Monitoring NPA at all branch levels is highly questionable. Efficiency of employees are highly errated one.



Aug 25, 2011

Loans are given to Real estate dupers,Microfinance sectors and not really eligible but borrowers who have right connexion, by our NPA s have risen and till recently Banks could easily hide the same.Now these get exposed.As long as the banks behave in this fashion they will create problems for their depositors and minority shareholders.


shome suvra

Aug 25, 2011

Concerning the present scenario in India leverage can cause systematic risk due to contagion effects of interrelated banks. Leverage is also partially caused by misperception of risk and mispricing of liquidity. Credit should be broad based and proprietary trading should be stopped.Hybrid instruments are preferable and they should be converted into equity on the discretion of RBI. Stress tests for the banks are welcome.


M.Dinakar Shetty

Aug 25, 2011

Nothing of that sort. There were days when public sector banks having 12 to 13% NPA still running smoothly. After implementing Bassle committee report, NPA monitoring brought the level down to 2.6% now, of course, in stages. But for any other factors, NPA rises is a different factor, otherwise, little variation to this or other side of NPA makes no difference for at least public sector banks. They are on solid path.



Aug 25, 2011

Ironically, and quite truly, if unchecked most of our Pvt Banks will actually tumble.
Having been a part of one such institution I can quote with examples the Funding, where until date approx Rs 300 Crores needs yet to be recovered from Cash that was distributed without ascertain g any credentials.
Unfortunately, most of the TOP Ranking Officials have no Bnaking Exposure, They are Mgt Graduates, who have No On Ground Experience and frame Policies for Funding.
Across different segments of Funding, whether On secured or unsecured loans, the bank went Berserk, and I wonder how despite its non recoveries , the bank posts of a healthy Balance Sheet. The NPA's are surmounting and the credit worthiness has not been ascertained.
I am told that the bank Has Connections in the right places, and I wonder, when this particular Bank will spell Doomsday to our Economy.
When things really went Bad, the CEO of the BANK mentioned about 4 C's. CASA, Credit Worthiness, Capital Adequecy at all costs and She herself.
Unfortunately, having Wrong people in Right Places vcan only spell doom, and that's what this bank is all about.



Aug 24, 2011

very good & helpful article.



Aug 24, 2011

the banking sector cannot be insulated fully from the swings of the economy. but, with strong checks and balances and controls in place our banking industry is better placed than in other countries to weather the storm. incidentally, it is strange that an advisory service like yours which harps on long term views and long term investment should talk about quarterly results. Only annual results count!



Aug 24, 2011

nationalized banks finances are 'guided'irrespective of its quality.SBI is one example of such aggressive financing.other nationalized banks are following the suit.
why pvt banks are not showing such steep rise in NPAs?
Inspite of stringent RBI norms,siutation is not likely to improve,particularly so, if int. rates rises further.if PSU banks praised, it is overdone.


ketan parekh

Aug 24, 2011

I do not think so.But maybe it is time to be cautious.

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